The Section 199A tax deduction is the best small business and individual investor tax break of the 21st century, coming out of the 2018 Tax Act.
Using Section 199A, business owners and real estate investors may get to simply “not” pay income taxes on the last 20% of the income they earn. This applies to all businesses who were in business as of January 1, 2018. The deduction only appears on tax returns for the years 2018 through 2025. It’s a temporary loophole.
And the best part? You don’t need to spend any money at year end or suffer through mind-numbing complexity.
I sat through a 1 hour session on this (which really needed to be a full day), and as I sat in class, it came to me that the folks that make these rules up at the IRS HQ surely keep tax CPA’s in business. I am sure they sit around for hours coming up with exceptions to the rules and exceptions to the exceptions. My mind was pretty numb after this and I believe that the tax software programmers have got to be on their toes to make sure the calculations get tabulated properly.
So, all you need to know is that you need to ask your tax CPA if you qualify for this Section 199A deduction.
Here is my best effort in “simplifying” the deduction rules:
- The Section 199A deduction gives owners of pass-thru business entities (e.g. sole proprietors, partners in partnerships, some real estate investors, and S corporation shareholders) an extra deduction equal to 20% of their business income.
- The Section 199A deduction can’t exceed 20% of your taxable income, and is limited to the lesser of that or the Qualified Business Income.
- What is Qualified Business Income?
- Qualified business income includes sole proprietorship profits, real estate investor rental income (if your real estate investing rises to the level of a trade or business), and the shareholder and partner “profit allocations” reported on the K-1s that S corporations and partnerships send their owners
- Qualified business income excludes income earned outside the United States. The qualified business income deduction only applies to domestic income (not foreign income).
- Qualified business income excludes S corporation shareholder-employee wages, guaranteed payments made to partners of a partnership, or other amounts a partnership pays to a partner for services.
- Qualified business income excludes capital gains, interest income, or dividend income
- Single taxpayers with taxable income more than $157,500 and married taxpayers with taxable income more than $315,000 will be limited or phased out of the deduction. There are too many rules here to add however, your tax CPA can run the numbers.
- All the standard professionals (Accountants,Doctors, Attorneys, Consultants), investment professionals, athletes, performers, and any one-person celebrity businesses (someone earning appearance fees or product endorsement income) face another equally painful phaseout.
Here are some suggested tax planning ideas to be able to use this Section 199A:
- MAXIMIZE YOUR QBO (QUALIFIED BUSINESS INCOME)
- S corporations and partnerships, for example, want to look at dialing down shareholder-employee salaries as well as partner guaranteed payments.Sole proprietors should reassess whether it makes sense to pay family members wages.Business owners operating both inside and outside the US may want to look at moving business activity back into the United States.
- DIAL DOWN YOUR TAXABLE INCOME
- If a taxpayer will lose the Section 199A deduction or some of the deduction due to a high income, reducing taxable income delivers big benefits.
- KNOW THE LIMITATIONS IF YOU ARE POSSIBLY GOING TO BE PHASED OUT
- If your Section 199A gets limited due to wages or depreciable property, creatively explore what you can do to bump your wages or depreciable property.Sometimes, a shareholder-employee in an S corporation may benefit from bumping up his or her wages—in spite of the additional payroll taxes—because those larger wages support a larger Section 199A deduction (you have to do the math for your exact situation in order to be sure).
- USE THIS DEDUCTION WISELY. (FOR FOLKS AGGRESSIVELY SAVING TOWARDS FINANCIAL INDEPENDENCE)
- Someone who receives a $50,000 Section 199A tax deduction might just use that deduction to dial down their income taxes by $12,000.But you could choose to use the deduction and the savings in more creative ways.One example? If you’ve put a $50,000 “free deduction” on your tax return, maybe you use that deduction to shelter $50,000 of Roth conversion income and maybe you do this for the next several years.
For more information, contact me at Nesha@paicpapllc.com. But make sure you ask your tax preparer about this jewel!